Drilling Down Into Airline ETFs: FAA vs. FLYX

Exchange-traded products were first introduced over two decades ago to give investors alternative options to high cost mutual funds. Since then, the industry has grown exponentially, with assets now over $1 trillion, and the total number of ETPs on the market eclipsing the 1,100 mark with new funds debuting all the time. But now that ETFs have taken all of the largest and most popular slices of the market, many have begun to compete with each other for dominance in very specific niches.

The competition was largely initiated by Vanguard funds, who began releasing ETFs with similar exposure to popular, established products, but with much lower costs. The most prevalent example of this is Vanguard‘s VWO, versus the iShares EEM. Both ETFs track the MSCI Emerging Markets Index, but EEM was on market for quite some time before VWO was introduced. VWO debuted with an expense ratio 45 basis points cheaper than the popular EEM and has since surpassed the fund in assets under management. Another popular example is in the gold space, where iShares slashed expenses on their popular gold product, IAU, in an attempt to catch up to State Street’s GLD, one of the most popular ETFs available today.

As the investing world saw the benefits of slashed expense ratios, new issuers decided to try their hands in the cost-cutting race. Enter Direxion, a firm that, until recently, had only offered leveraged and inverse products. At the end of 2010, the issuer launched one of their first ETFs without leverage, the Direxion Airline Shares Fund (NYSE:FLYX), in order to compete with the reasonably popular Guggenheim Airline ETF (NYSEARCA:FAA). FAA has been on the market since January of 2009 but has failed to gain significant attention in its two years of trading, with just $34 million in AUM but Direxion’s airline fund could present significant competition thanks to its expense ratio of just 55 basis points compared to FAA’s rate of 0.65%.

FAA tracks the NYSE Arca Global Airline Index, which is a modified equal-dollar weighted index designed to measure the performance of highly capitalized and liquid U.S. and international passenger airline companies identified as being in the airline industry and listed on developed and emerging global market exchanges. Some of the top holdings include Southwest Airlines (NYSE:LUV) (14.4%), Delta Air Lines (NYSE:DAL) (13.6%), and AirTran (AAI) (4.6%). The fund splits its exposure 70/30 between domestic and international securities. Thus far in 2011, this fund has lost 9.7% which is likely related to skyrocketing oil prices which have greatly hurt the transportation industry at large.

FLYX tracks the very similar NYSE Arca Airline Index, which is designed to measure the performance of highly capitalized and liquid U.S. and international passenger airline companies identified as being in the airline industry and listed on developed and emerging global market exchanges. FLYX features a few different names in its top holdings, though it still offers heavy allocations to Southwest (7.2%), and Delta (8%). Like FAA, this fund’s exposure is near 70/30 for domestic and international assets. FLYX differs in its international exposure, however, in that its overseas investments focus on Latin America, while FAA focuses more on Europe. FLYX has had a rough year as well, losing over 11% thus far.

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Direxion’s move initially made sense, as it seems that historically cheaper funds have caught up to their more expensive counterparts, but thus far, FLYX has yet to make a dent in the industry. FLYX has a meager $3.50 million in assets and has a average trading volume of just 1,798. So why has this cheaper alternative been so slow to catch on? Well, it seems that investing in airlines via ETFs has yet to pick up steam, as FAA still has a low amount of assets by the industry’s standards. While it may be the biggest airline fund, the fact remains that perhaps investors are not interested in gaining exposure to airlines via the ETF wrapper. Another possible issue for the young product could be rising oil prices. Higher crude spells bad news for the airline industry, as we saw in our most recent recession. FLYX launched in December of 2010 at an inopportune time, as crude has now jumped over $100 per barrel with majority of that spike coming in the last six weeks. No matter what the reason, FAA continues its dominance as the top airline ETF by a wide margin.

Disclosure: Photo courtesy of Dylan Ashe. No positions at time of writing.

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